Today’s plunge in the market decisively broke the nine-month consolidation top and makes it clear that we are in a bear market. Furthermore, today’s frantic activity in Washington on the part of Congress, the Administration and the Fed is a definite acknowledgment that we are either entering or are already in a recession. The nine-month topping process in the market was a typical period where a bullish consensus had evolved into one where investors were split on the outlook for the market and the economy. Now the doubt has been resolved to the downside, and the market, only now, is beginning to price in a recession of yet unknown depth and duration. It is far too early to look for a bottom in the face of what is to come—lower earnings estimates, more big write-offs and disappointing economic numbers. As the table below indicates, the last eight recessions over 53 years were associated with an average decline in the S&P 500 of 30%. At the close today the index was down 15% from its October peak.
| |
MARKET |
|
ECONOMY |
|
|
| |
PEAK |
P/E |
TROUGH |
P/E |
S&P 500
DECLINE |
PEAK |
TROUGH |
|
| |
8/1956 |
16.2 |
10/1957 |
12.3 |
21.6% |
8/1957 |
4/1958 |
|
| |
1/1960 |
17.2 |
10/1960 |
14.8 |
14.1% |
4/1960 |
2/1961 |
|
| |
2/1968 |
19.9 |
5/1970 |
10.9 |
37.3% |
12/1969 |
11/1970 |
|
| |
1/1973 |
15.9 |
10/1974 |
7.3 |
49.9% |
11/1973 |
3/1975 |
|
| |
2/1980 |
8.9 |
3/1980 |
7.0 |
21.6% |
1/1980 |
7/1980 |
|
| |
11/1980 |
10.5 |
8/1982 |
7.0 |
28.5% |
7/1981 |
11/1982 |
|
| |
7/1990 |
17.8 |
10/1990 |
14.1 |
20.4% |
7/1990 |
3/1991 |
|
| |
3/2000 |
37.3 |
10/2002 |
15.5 |
50.5% |
3/2001 |
11/2001 |
|
| |
10/2007? |
23.1 |
? |
? |
? |
? |
? |
|
| |
AVG. |
18.0 |
|
11.1 |
30.5% |
|
|
|
Those looking for an imminent bottom claim that the bad news is discounted and that stocks are cheap. Others concede that there may be more to go on the downside, but are buying for the 3-to-5 year outlook. We doubt that all of the bad news is discounted now since there is a lot that we still don’t know about the overall financial and credit situation and we are still getting negative surprises on a regular basis. Earnings estimates for 2008 are only now beginning to be marked down—there is a lot more to go. Furthermore in seven of the past eight instances shown in the table above the decline in the S&P 500 has been significantly higher than it is to date. As for stocks being cheap, the P/E on trendline 2007 earnings was 23 at the October top, far higher than in any instance except for the dot-com boom of the last cycle. The P/E is still 19.5 today, higher than it was at six of the last eight peaks.
Although buying now for the next 3-to-5 years may pay off, it’s still a gamble. At the close today the S&P was at about the same level as it was on April 30, 1999—that’s almost nine years with no gain other than a small dividend yield. In our view the market is headed far lower, although there will probably be deceptive rallies along the way. At some point there will be a final capitulation on the part of investors. Until then, this remains a dangerous market.
NOTE: The P/Es in the above table are based on trendline (smoothed) earnings. This avoids the distortion of unusually good and bad years and gives a truer indication of market valuations than provided by the raw numbers.
